The first part of this article discussed the history of bad faith and how, after a time, it became limited by courts under the reasonable basis or fairly debatable standard. Now, some recent cases have gone even farther afield from traditional bad faith cases.

Executive Summary

Make no mistake: Bad faith has returned, according to two members of Cozen O'Connor's insurance practice, Stephen Pate and Karl Schulz. In this two-part article, the authors note that recent hurricane and catastrophe claims and alleged poor claims handling associated with those events are one factor, as courts have started wearing away at "fairly debatable" and "reasonable" standards that protected insurers from bad faith in prior years. In Part I, they reviewed the history of bad faith litigation and recent cases in New Jersey and Colorado eroding the "fairly debatable" defense. In Part II, they review more troubling decisions, in which courts have held that negligence can be the basis for bad faith causes of action.

Waters Get Muddy

In Texas, after a long absence from the subject, the Supreme Court recently attempted to clarify bad faith standards. USAA Texas Lloyds v. Menchaca was a Hurricane Ike case involving allegations of Texas Insurance Code violations. (This code is based upon the Uniform Unfair Claims Settlement Practices Act.) A jury found that the insurer failed to conduct a reasonable investigation but found no breach of the policy.

The insurer asserted that the “no breach” finding disposed of the insured’s other claims.

The insured asserted that the jury’s findings should be viewed independently of the “no breach” finding. The trial court agreed with the insured, and the intermediate appellate court affirmed.

On review, the Texas Supreme Court began with the general rule that an insured cannot recover policy benefits for an insurer’s statutory violation if the insured does not have a right to those benefits under the policy. The court then made it clear that the general rule was not to be applied as a blanket preclusion of any kind of bad faith liability if the policy does not cover the claim. The court held that the insurer’s statutory violation—its failure to conduct a reasonable investigation—caused the insured to lose its contractual rights and affirmed the jury’s award based on statutory violations.

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